BUSINESSWEEK ONLINE : APRIL 17, 2000 ISSUE
COVER STORY Why Gates Is Rolling the Dice Risking breakup, he'll forge ahead with his all-in-one Web strategy Judgment Day. Nearly two years after the government filed its antitrust suit against Microsoft (MSFT), it is finally here. Judge Thomas Penfield Jackson ruled on Apr. 3 that the software giant indeed violated the Sherman Antitrust Act by attempting to monopolize the Web-browser market. His ruling clearly brands Microsoft Corp. as a lawbreaker and, presuming it withstands appeal, increases the risk that the company will someday pay a price for its misdeeds. The government is scheduled to submit its proposed remedies by the end of April--with a decision from Judge Jackson expected soon after. But the stock market has already rendered its judgment: This is dreadful news for Microsoft. In the three trading days after negotiations between Microsoft and the Justice Dept. broke down on Apr. 1, panicky investors dumped the stock, sending its price down nearly 19%. And jitters over Microsoft were a key catalyst behind the huge tech-stock sell-off that convulsed the market for much of the early part of the week. So why didn't Microsoft Chairman William H. Gates III avoid this hassle and settle? After all, the government was offering something less than a breakup of the company. It mainly wanted Microsoft to offer a version of Windows without a browser attached and called for new rules that would limit the company's ability to control what technologies it adds to its operating system. The answer is simple: In a bold roll of the dice, Gates decided not to accept any solution that would fence Microsoft in just as the company is struggling to compete in a new Internet-based world. Plus, he thinks he can stave off draconian remedies. And while the case drags on, Gates keeps the government out of his hair. The company's freedom to beef up Windows, says Gates, is ''not only important to Microsoft and its shareholders, [it's] important to all consumers, and even to the economy that we're all experiencing.'' Strip away the flag-waving and you get to the essence of Gates's reluctance. Bottom line: Integrating new features into Windows is critical to Microsoft--and the company can't afford to have the government deciding what belongs and what doesn't. It attached a Web browser to Windows 95 five years ago because it had become clear that people wanted to access the Web--and that Netscape Communications Corp.'s popular Navigator browser was shaping up as a rival to Windows. The company believes that if it can't add new pieces of Web technology to Windows, it will be left behind as consumers and businesses increasingly adopt the Internet--rather than the personal computer--as the center of their computing universe. It's no wonder, then, that Microsoft and Justice are at loggerheads. Microsoft needs to turn Windows into a new kind of operating system designed to fully exploit the Internet. And Justice wants to prevent Microsoft from taking advantage of its Windows monopoly to establish the kind of stranglehold on the emerging world of e-business that it now has over the PC industry--and that it used to dominate in browsers. ''It's clear that any antitrust remedy in a monopoly case has to be forward-looking because otherwise you would forever be playing catch-up,'' says Justice Dept. antitrust chief Joel I. Klein. So, no deal. Now, as long as Judge Jackson doesn't issue an injunction that handcuffs Microsoft, the company is free to forge ahead with its technology plans without government interference while the appeals process grinds on. And forge ahead it will. Already, Microsoft gives away a Web browser as part of its Windows 2000 operating system for business users. And it includes so-called Web-server software for free with each copy of the Windows 2000 version that runs the powerful server computers that are the traffic cops for corporate networks and Web sites. The company is creating new devices to carry its software into cheap Net access systems. And now, the company is in the process of creating strong links among all of its versions of Windows software. In essence, there's going to be just one big Windows that runs on everything from notebook computers to huge servers. Despite its immense clout, though, Microsoft faces a tough road in trying to replicate its desktop dominance on the Internet. Steven M. Sakoman, chief operating officer at Be Inc., maker of the Be operating system and the new BeIA operating system for Internet appliances, points out that the Redmond (Wash.) giant so far is only a bit player in the hot new Net appliance and handheld markets. And on Apr. 5, the competition got tougher when America Online Inc. unveiled its new Netscape 6 browser. Microsoft has scheduled a full-day conference on its new Internet strategy for analysts and the media in May. The company expects the event, dubbed Forum 2000, to have every bit of the impact of a similar meeting it held back in December, 1995, when it announced that a Web browser would soon be a free piece of software integrated into Windows. That decision launched the so-called browser war with Netscape--and, ultimately, brought the government down on Microsoft. Many in the business see the same old Microsoft at work. ''They have a vision that is breathtaking,'' says one computer-industry executive. ''They want to dominate the Internet.'' The company has a nerdy name for its new plan: Next Generation Windows Services. Essentially, the idea is to plant bits of software in the versions of Windows for desktop PCs, corporate servers, and Web sites that make them fit together and mesh with the Web like hands in gloves. Someone buying a pair of baseball tickets, for example, could click to buy the tickets online. Then, automatically, the system would bill the user's credit card, put a memo on the PC's calendar, and zip an e-mail to a friend the ticket buyer wants to take to the game. Many Net companies are already developing such services for the Web, but Microsoft hopes to redirect all those efforts into writing for Windows. HEARTS AND MINDS. Microsoft will also offer powerful incentives for businesspeople. Web-site operators would no longer have to build all the capabilities they need themselves. Companies that sell products on a Web site, for example, could tap into a Microsoft service called Passport, which handles confirmation of customers' identities and authorization of credit-card transactions. This is how Microsoft won the hearts and minds of software developers in the past. Once developers start building on a Microsoft platform, it's difficult to switch to another technology. ''I appreciate having somebody else build this stuff so I can concentrate on my own products,'' says Tony McAlister, vice-president for information services at Buy.com, a popular e-commerce Web site. The new Internet strategy is so crucial to Microsoft that Gates turned over his CEO duties to Steven A. Ballmer in January largely so that he could focus on it. But by declining the government's olive branch in order to push Windows onto the Net, Gates is also taking a calculated risk. He may have pushed Klein into a position where he has no choice but to seek a breakup. ''Now that settlement talks have broken down, we are back to square one. I would be surprised if the government didn't ask for some form of structural relief,'' says Stephen D. Houck, who served as lead lawyer for the states before returning to private practice late last year. Klein and the 19 state attorneys general involved in the case are expected to insist on denying Gates complete control over the Windows operating system no matter what new markets Microsoft may enter. ''The case is about preventing bundling from blocking competition and stifling innovation,'' says Connecticut Attorney General Richard Blumenthal. ''Requiring that there be no tying or bundling would be an appropriate remedy.'' That's heresy to Gates--but he has some grounds for hoping that he'll prevail in the end. First, there's the Bush card. In March, the GOP Presidential candidate told Microsoft executives that he opposes a breakup. While Bush later backed away a bit from that statement, Microsoft executives are plainly consoled by the fact that Klein may soon be leaving office. More important, Jackson's decision may not hold up. Unless the two sides settle, U.S. v. Microsoft would ordinarily be decided by the conservative District of Columbia Circuit Court of Appeals. But in a scheduling meeting on Apr. 4, Jackson said he might push for an immediate appeal to the Supreme Court. If that happens, or if the case is ultimately appealed to the high court, Microsoft would face a fairly friendly audience. ''It's highly unlikely that Judge Jackson's opinion would travel through the higher courts unscathed,'' says George Washington University antitrust professor William Kovacic. The key weakness in Judge Jackson's opinion is the issue of tying: whether it was legal for Microsoft to bundle its Internet browser into its operating system. In an earlier case involving Microsoft's 1994 consent decree with the Justice Dept., the appeals court said that the software giant should have the right to wrap a new feature into Windows if it can show any ''plausible benefits'' to consumers. In a highly unusual step for a federal trial judge, Jackson disregarded this guidance and said it was inconsistent with Supreme Court precedent. That certainly won't win Jackson any friends on the D.C. Circuit and may not go over so well with the Supreme Court, either. NERVOUS JUDGES. A second potential weakness in the government's position: While the case revolved around Microsoft's effort to conquer the browser market, many of the possible remedies look ahead to the Internet and corporate-enterprise markets. The company will argue that's not fair. Under fundamental constitutional principles of due process, punishment has to be closely related to the crime. And judges may be nervous about imposing a remedy that goes too far beyond the proof offered at trial. George Mason University antitrust scholar Ernest Gellhorn thinks that whichever high court hears the case may say: ''We are not going to allow any conduct remedy where we don't know what the effect will be.'' The issue is not as black and white as Microsoft would like folks to believe, however. There have been plenty of antitrust cases in the past in which the government has imposed forward-looking remedies. ''The relief does not have to be confined to the exact offenses,'' says Brookings Institution antitrust scholar Robert E. Litan. Nonetheless, Gates clearly has some cause for hope. Given the questions about Jackson's ruling and the fact that there's little direct harm that can be attributed to Microsoft's predatory actions, he seems to believe that it's unlikely that higher courts will approve a breakup. What's more, the company can truthfully argue that its supposedly anticompetitive behavior hasn't done it much good in new markets such as handheld devices and high-end servers. If he's right, Gates probably won't receive a punishment much worse than the one the government was proposing in settlement talks. By the time anything is resolved, Microsoft's Windows will likely be so tightly interwoven with the Web that it will be impossible to extricate. So--Wall Street histrionics aside--Gates may stand a chance of rolling sevens. By Jay Greene in Seattle, Mike France in New York, and Dan Carney in Washington, D.C., with Peter Burrows in San Mateo To read a letter to the editor about this story, click here. _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS Is the Party Over? COVER IMAGE: Wall Street: Is the Party Over? CHART: Tech Comes Back to Earth CHART: Internet Stocks Take a Dive TABLE: The Move to Quality Margin Calls: Not a Lot of Wiggle Room Time to Keep a Cool Head TABLE: Why You Shouldn't Sell in a Panic The Dot-Coms Are Falling to Earth TABLE: The Internet Shakeout Why Gates Is Rolling the Dice TABLE: Bill's Vision ONLINE ORIGINAL: "Ultimately, the Market Gets Priced on Fundamentals" ONLINE ORIGINAL: BW's Bill Wolman on the Stampede to Quality (Video) ONLINE ORIGINAL: Oppenheimer Funds' Marci Rossell on the Market in the New Economy (Video) INTERACT E-Mail to Business Week Online

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